Many commercial transactions involve payment for goods or services by way of a check. A check directs a bank (the payor bank), with which one party (the payor) has a checking account, to pay another party (the payee) a specified sum of money from that checking account. The payee then deposits the check in his or her bank, which is usually referred to as the bank of first deposit (BOFD). The BOFD, which is usually not the payor bank, then endorses the check, provisionally credits the depositor's account with the amount of the check, and either deposits the check directly with the payor bank or deposits the check indirectly with the payor bank through one or more intermediaries, such as one or more Federal Reserve Banks or other banks or check clearinghouses. When the check arrives at the payor bank, it may be honored by the payor bank which then debits the account of the payor in accordance with the amount of the check. It may also be dishonored by the payor bank in which case the check is returned to the BOFD either directly or indirectly through the same or different intermediaries which were involved in the transfer of the check from the BOFD to the payor bank.
This process involves actual physical transfer of the check from institution to institution in the path between the BOFD and the payor bank. This is a costly labor intensive process subject to a great deal of human error. In addition to high cost and opportunities for error, there also is a significant time delay between the presentation of a check at a BOFD and the arrival of that check at a payor bank. There also is an additional time delay involved before a BOFD can get notification that a payor bank has dishonored a check and is returning it to the BOFD. These time delays significantly enhance the financial risk to banking institutions involved in check clearance procedures. This is due to Federal banking regulations which require that funds be made available to the check depositor for withdrawal within a short time after check deposit.